05 March 2012

The European Union’s Emissions Trading System (ETS), the world’s biggest carbon market, has two main aims. One is to restrict the carbon-dioxide emissions of the 11,000 companies trading on it to an agreed cap. The other is to give these firms an incentive to invest in clean technology

On the first count, thanks to the economic malaise, the ETS is a success: its participants’ emissions are well below the current cap. On the second, for the same reason, it is failing wretchedly. Oversupplied with permits, the market has tanked. Having reached nearly €30 ($47) a tonne in 2008, the carbon price is now persistently under €10: much too low to prod firms to make their investment plans greener.

The situation is about to get worse. The EU is in the process of selling an additional 300m permits to raise cash for green energy projects, adding to oversupply. It is also about to introduce a new regulation on energy efficiency, which will further reduce emissions and which was not factored into the current cap. Matthew Gray of Jefferies, an investment bank, reckons that by 2020 the ETS will have an accumulated surplus of 845m permits, against a planned cap that year of 1.8 billion permits.

Investors in green technology are pleading for intervention to prop up the carbon price. Various ways have been suggested, from setting a carbon floor-price to tightening the cap. In December, when the carbon price fell well under €7, a committee of the European Parliament recommended three possible strategies: withhold—or “set aside”—an undetermined tranche of permits from the market; withhold 1.4 billion permits; or tighten the cap. On February 28th a higher-powered committee approved the first strategy. It will now be voted on by the parliament; if passed, the details will be negotiated with member states.

This is a familiar sort of Eurofudge. The simplest thing would be to tighten the cap, so that the carbon price rises to somewhere between €15 and €30, the range regulators had in mind for it. Yet this would be furiously resisted by heavy emitters such as Poland, which burns lots of coal. And it would set a meddlesome precedent, another way to deplete investor confidence. To address that worry, the set-aside would ideally be no bigger than the reduced demand for permits resulting from the energy-efficiency rule, which is the ostensible reason for acting.

That would be a modest measure: the carbon price actually fell in response to the committee’s announcement. And even then it will require fraught negotiation. Meanwhile, the market’s overseers are left dreaming of a sudden economic upturn or a new American or Japanese cap-and-trade scheme to boost demand for ETS permits—in short, for a miracle.